On Friday we asked if the student debt bubble was about to witness its 2007 moment. In July of that year, all three ratings agencies turned aggressively negative on subprime-related MBS and their collective actions triggered a pre-crisis crisis in Canada where billions of asset-backed commercial paper stopped rolling in August, offering those who were inclined to take notice a window into what the financial would look like just one year later. Earlier this month, Moody’s put some $3 billion in student loan-backed ABS on review for downgrade citing a risk of default in some tranches. As a reminder, here’s the rationale:
The reviews for downgrade are a result of the increased risk that the tranches will not fully pay down by their respective final maturity dates. Failure to repay a note on the final maturity date represents an event of default under the trust documents.
Voluntary prepayment rates in FFELP loan pools remain historically low as a result of sluggish economic growth and high unemployment rates among recent graduates. Although prepayments rose to 2%-3% of the loans in repayment in 2014, partly as a result of borrowers refinancing their FFELP loans through private student loans and Federal Direct consolidation loans, prepayments remain low relative to historical levels. Deferment and forbearance levels remain high throughout the life of the collateral pools.
The collateral backing the paper is FFELP student loans — that is, it’s guaranteed for 97% of principal by the US government. With nearly one in three loans in repayment delinquent by 30 days or more, and with $1.3 trillion in student debt outstanding, we’ve suggested the situation could deteriorate materially going forward and we’ve also noted that it won’t be long before this trillion-dollar mountain of liabilities ends up being socialized because as Bill Ackman says “there’s no way students are going to pay it back.”